The Stock Market Has Entered Bizarro World

Indexing is screwing up a lot of things. This is not news. Equity investors focused on bottom-up, fundamental analysis have been complaining for years about how hard it is to make money. They complain about valuations being too high and out of whack with reality. They complain about how the market goes up every day. They complain about how things don’t make any sense. The stock market has entered Bizarro World, and nobody really knows why, but they suspect that this is all somehow related to indexing, which, as a strategy, has attracted trillions of dollars in assets under management.

That assessment is correct. And there is precedent for all of this. If you go back 10 years to the commodities bull market of the late 2000s, you may recall that people began to believe that raw materials were an asset class with entirely different characteristics than equities and fixed income, and one that is less correlated, providing diversification benefits to any portfolio. And so people began to invest in commodity index swaps, swap agreements that gave exposure to a broad basket of commodity prices. Since investors typically only bet the price would go up with these agreements, the proliferation of these index swaps put upward pressure on the price of commodities.